Mid-Cap Cement - Sector Initiation - Troubles receding, valuations can soar

Mid-Cap Cement - Sector Initiation - Troubles receding, valuations can soar

Troubles receding, valuations can soar



We initiate coverage on mid-cap cement companies (JK Lakshmi, Prism
Cement, Mangalam Cement and Orient Cement) with a positive view as we
believe that these companies will benefit from improving demand-supply
dynamics and improved utilization rate of the industry. We believe
mid-cap companies will surpass the earnings growth CAGR of large cap
companies in the next few years led by higher volumes on the back of
capacity additions and higher operating and financial leverage. The
valuation gap between mid and large cap companies tend to narrow in a
cyclical upturn which should provide more room for upside. In this
space, our top pick is JK Lakshmi Cement (sharp increase in
capacities) and Prism Cement (turnaround story).

$ Mid-cap companies ready to take the leap, attractively placed to
large players: Mid-cap cement companies will post higher volume growth
in improving demand scenario due to higher capacity additions compared
to large players. Most of these companies are operating at higher
utilization rates compared to large players due to their presence in
favourable regions. Mid-cap companies tend to re-rate in a cycle
upturn due to high operating and financial leverage and valuation gap
with large cap narrows. On EBITDA growth vs. EV/EBITDA scatter, we
find that mid-cap companies are attractively placed compared to large
players.

$ Pace of capacity addition slowing down; demand may outpace supply:
We expect the pace of capacity addition to slow down post FY15E which
will lead to higher utilization rate.  We expect installed capacity to
grow at a CAGR of 5.1% between FY14-FY17E and with expected demand
growth at 8.5% CAGR, effective utilization rate of the industry should
improve going forward. Post a decline in industry utilization rate to
72.8% in FY14, we expect it to improve gradually to 79.6% in FY17E. We
believe new players will restrain themselves from entering the cement
business as the RoCE seems to be very low for a new greenfield plant
at current prices and at the same time, regulatory hurdles will delay
commissioning of fresh capacities.

$ Cement prices to remain strong, coal cost pressures seem to be
moderating: Cement prices are dependent on improvement in cement
demand historically and with our expectation of improvement in cement
consumption, prices should remain firm. The manufacturers were not
able to pass on the increasing costs to consumers due to low demand
and surplus capacities for last few years. Cement prices have remained
at higher levels in the past few months, which will benefit the
companies going forward. There has been moderation in imported coal
prices in the past one year which will also help cement companies.

$ Outlook and key risks:  Our top pick in mid cap space is JK Lakshmi
Cement followed by Prism Cement. We believe JK Lakshmi will benefit
from capacity addition and presence in favourable markets. Prism
Cement is a turnaround story where revival is visible in the Cement
segment and TBK segment is also on the verge of revival. Key risk to
our thesis is continued slowdown in infrastructure activities which
will impact cement prices.